September 10, 2014

Philippines: The Story of Inflation

The prices of goods in the Philippines
has started to increased significantly. The concern of people,
specially those with lower income, is that the number of goods in
their market basket are getting fewer.

People believed that the prices of
basic goods should be regulated. Yet, what if the despite the
protest, prices keep increasing?

Let me tell you a story on how price
increase (inflation) happens. The basic cause of inflation is
increased in demand for a specific good (supply shocks can also
impact the price in some cases). Imagine that there is a cake, only
those who have money can buy a cake. The cake was divided into ten.
There were twenty people in the town, only ten of them have jobs and
can buy a cake. The ten people shared equally on the price of cake.
After a year, a young man graduated from college and found a job.
After earning, he decides to reward himself with a cake – because
he has not eaten a cake. However, the cake can only be divided into
ten, now there are eleven of them who wants to eat the cake. The
baker got curious and asked himself; "what will happen if I doubled the price of cake"?
The baker said, “I'm doubling the price of cake”. eleven man
said, “it's okay we will still buy it”. The young man was not
able to get a share since there are only ten slices of cake. The next
day, the baker announced that he is tripling the price
of cake. The young man, because of his curiosity, was the first to said “yes I'm still buying it”! The
other ten man pause for a while; two man said “we think that is too
much, we are not going to buy”. The other eight said, “we are
going to buy”. The two loyal customers left the bakeshop, now there
are only nine of them sharing for ten pieces of cake. The baker
realized at the end of the day that he earned a lot from new
combination of nine customers rather than the previous combination of
ten; and, he was able to eat the last piece of cake.

The above scenario is an example of
price increase. If the demand did not increased, the baker might not
thought of increasing the price. In the economy, there are new
graduates, like in the above example, that will buy a good even if
the price is high – because they want the new experience and already have the money. On one hand, from previous mass production
(baking as many cakes as possible to earn) the baker become
profit oriented; he now knows that he can earn more even if he is producing less.

You might asked, what if after the announcement none of the customers bought the cake? Surely, after a
week or month, price will go down. In this case, the decline in
demand will trigger the price down.

In the long run, supply of goods are
fixed, too much consumption can push the price up. By consuming the
right amount of goods, you are helping the economy, the low income
people, and your savings account.

In present, notice that prices of foods are
increasing while prices of clothes are declining (on sale), think
about it, think about the above scenario.

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